The Craziness of Real Estate in LA

So, I had lunch yesterday with some friends.  These are close friends that we’ve known for quite a while.  It was nice, I haven’t seen them in a while, and they are moving into an apartment together. (CONGRATS!) Moving is just such a painful, excruciating time.  But, it came up that they want to buy a place and they are looking to buy something so that they can build equity and all this other blah, blah, blah.

The Mrs and I have our own thoughts on buying vs renting, especially around these parts.  Everyone that I talk to says

You have to buy around here, you’re throwing your money away by renting.  Real Estate ALWAYS goes up!!!

I mentioned that it just doesn’t make any sense to buy a house where we live, and I was scoffed at.  So, I figured I’d look into it and see if I was right.  So, here we go, Fun With Math:

Rule of 15:

This is just a rule of thumb (and as such doesn’t do a lot of detailed analysis), but it is a back of the napkin calculation of whether you should rent or buy in an area.  The basics say, if you take the annualized rent (12 * the monthly rent) and multiply it by 15 (or simpler take the monthly rent * 180) you get the approximate break even value of a home purchase between renting and buying.

Example:

You’re torn between renting a condo or buying one.  You can rent a place for $1,000 a month.  So:

$1,000 monthly rent * 180 = $180,000

So if you can buy something equivalent for less than $180K, it’s cheaper to buy.  If you can’t, it’s cheaper to rent.  Simple.

Back to our friends:

I asked for their address, punched it into Redfin to find this gem:

This 1,400 square foot condo features 2 bedrooms and 3 bathrooms. This property was built in 1972 and last sold for $595,000 in July 2007. Based on Redfin’s data, we estimate the home’s value is now $650,476, which is 9.3% more than when it was last sold.”

I didn’t think this was possible seeing that every other property in this zip code is well into the 7 figure range.  Alas, there were other condos that sold right around this value in the same area, purchased as recently as a month ago.  So, there you have it, I don’t usually put stock in Redfin and Zillow’s property values, but seems reasonable, especially since this is higher than the comparison properties.

I didn’t ask what they are paying in rent, but I’d have to imagine it’s somewhere in the neighborhood of ~$2,000.  Sure, I’m guessing, but I know the area fairly well, and that seems reasonable.  So, the sniff test, the good ol rule of 15, how does that work on here:

$2,000/month * 12 = $24,000 annual rent
$650,000/ $24,000 = 27 (WHOA!)

That right there tells you there’s some more number crunching that needs to go on here.

Let’s play make-believe:

So, me and the Mrs. buy a lovely condo on the hill in July of 2007.  We’re so excited to move into our new condo.  HOORAY!!!! So what did we need to put down for this thing?  Let’s put down 15% like a good rational human being (not that there were many of these at that point in time) so that’s $89,250.  And we continue to pay our $2,130 mortgage payment, and our $386/month HOA (yes, this is from one that sold a month ago).  And we decide to sell it now, for the value that our friends at Redfin say it’s worth.

So what does this mean?  Well, we made $55,476 in appreciation on the house.  For a $89,250 initial outlay.  Not bad.  But wait…

What about the HOA?  $55,476 – $46,320 ($386 * 120 months) = $9,126 Profit.
What about our lovely agents to sell the house?  $650,476 * 5% = $32,523 Commissions = -$23,367 Profit
What about the interest paid during this time? $134,458 = -$157,826 Profit
What about the repairs (1% of the value per year)? $5,500 * 10 years = -$55,000 = -$212,826 Profit

But for simplicity’s sake, let’s just take the appreciation and compare it to something else.  So: $55,476.

So, what do we do instead?

How about we just take our money and rent?  Let’s take the $89K and just put it into VTI in July 2007 (right before the crash mind you):

Graph of VTI

The value in July 2007 is $72.05.  Today it’s at $120.23.  So, just that alone gives us growth on our $89,250 of $59,500.

Wait What??? I thought real estate was the way to go?  What happened to the leverage?

$59,500 > $55,576 – both of which are taxed at capital gains rates, btw.

This is without any other of the fancy math that goes along with it.  It also doesn’t include any of the auxiliary benefits of not having to hassle with property tax or repairs or any of it.

Yes, you could argue that there are Mortgage Interest tax credits that would offset this a little.  But, you could also argue that the rent would be substantially lower than the mortgage payment, so we invest that and it would grow considerably more, especially buying through the dip in 2008/2009.

 I think we’ll stay put

I just did a quick calc on our place, and we have a price/rent ratio of about 29.  Which basically means our rent payment is half of what the mortgage payment would be.  The real estate prices here are insane.

In fact, if you use Paula’s One Percent Rule, you would need 340 months to recoup the cost being a landlord.  That’s basically a 30 year mortgage, just to break even on buying our little house as a rental investment.  WTF?!?!  Something is crazy outta whack here.

I know… I know, this is just one example, and there are 50 others that would go the other way.  But, considering that is one of the more expensive areas in LA, I was kind of shocked. I don’t know if this is a one-off thing, or what is going on, but just thought I would share.  But, it’s definitely worth considering, if a primary home is considered a good investment.

17 Comments

  • Gwen @ FieryMillennials April 20, 2017 at 9:29 am

    Ha! Mine comes in exactly at 15…. good thing it’s actually 6.8 which is a better number by far! ($500 for one unit vs. the $1100 the house brings in) I’ll stick to my boring Midwest landscape!
    Gwen @ FieryMillennials recently posted…Early Retirement: Everybody wants to be a bodybuilder, but…My Profile

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    • Mr WoW April 20, 2017 at 9:33 am

      You’re exactly right. It’s nuts to be here and see this going on. You hear a lot of big numbers being thrown around, but if you sit back and look at it, it doesn’t make a whole lot of sense.

      15 is the break even point, and you can go either way. Hell, I’d even say < 20 should give you some pause. But for us, we're in the 25-40 range. That's just craziness. The ones that make the money are the agents.

      Reply
  • Tonya@Budget and the Beach April 20, 2017 at 12:31 pm

    I’m going to send this to my dad and anyone else who is bugging me about buying something now that I’m “employed.” The “American Dream” needs to be re-written because it ain’t workin’ for most people in a lot of areas, especially here in LA. I mean, rent is high enough!
    Tonya@Budget and the Beach recently posted…Why Women Need to Be Talking About MoneyMy Profile

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  • The One In Debt April 20, 2017 at 1:50 pm

    Well, I figured out the calculation (in which I think/know my rent is atrocious). comes out I am still coming ahead by renting (by a house in LA for $325K. ya right!). I just wish I was renting a house (soon grasshopper). Because, while I have good neighbors, they are neighbors whose wall I share. Great post. thanks.
    The One In Debt recently posted…April 2017 Expense Report [Month 4]My Profile

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    • Mr WoW April 20, 2017 at 3:20 pm

      Glad to hear it. And you bring up another great point… If you don’t like your neighbors, you just move. You don’t have to go through the hassle of selling or what ever else. This actually happened to us a while back. It’s definitely a personal decision, for a primary residence at least. But yeah, it’s complete craziness around here at the moment.

      Reply
  • Miss Mazuma April 20, 2017 at 4:20 pm

    I love all things real estate and this is no different! I dream of California as a possible future state or residence but I am well aware that my COL would be radically increased. I currently own but the more I read these calculations the less I care what happens in the future. I used to be in the homeowner only page but I see how that is slowly changing. I love the flexibility that renting brings…and with these numbers, I’ll never be able to buy in California anyway! 🙂
    Miss Mazuma recently posted…That Says a Lot About You.My Profile

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    • Mr WoW April 20, 2017 at 6:31 pm

      The more and more we are interested in this finance stuff, the more we realize how expensive it is to live here. The average house is about $600/sqft, depending on where you are. We used to live near the beach and houses there were >$1,000/sqft. But you can rent them for a “reasonable” price. And yeah, I found our kitchen sink clogged today…. “HEY LANDLORD!!”

      It’s a little nutty, but hey… we have great weather!!

      Reply
  • Stuart @ Epic Quiver April 20, 2017 at 10:54 pm

    Young couples out here in Los Angeles also forget that they are competing with a huge influx of Chinese multi-millionaires who are more than happy to pay above asking price and have held real estate up at inflated prices. I feel as if a mini-millennial home owner real estate bubble is in the making as young couples try to buy in at prices outside of what they can truely afford. 2br condos around Pasadena are going anywhere between $500k and $1.2m these days. It’s outlandish

    Reply
    • Mr WoW April 21, 2017 at 9:11 am

      I don’t know what and what doesn’t make a bubble. But, I will say that it’s completely … well, outlandish is a great word for it.

      It’s kind of amazing, I was talking to a friend of mine that is in real estate.

      And yes, there are a class of investors that I had never heard of before. They purchase houses as a value store. They aren’t interested in renting it for the cash flow, that’s just icing on the cake. They use these million dollar houses as the equivalent of a CD.

      It’s just smart to take a look, and not drink the KoolAid.

      Reply
  • Mr. Need2save April 23, 2017 at 3:40 am

    And I thought home prices in the DC metro area were bad! The home prices in many desirable areas of California are insane. Given your situation, I would do the same thing and rent. Although I enjoy my occasional trips to San Diego for work, I don’t see us ever living in California – just too expensive to live there.

    We’ve never considered our home an investment. Although we did make a modest profit on our last two homes, we will not make any money on our current home. But that’s ok for us, as we’ve really enjoyed the location, the views, and the peace and quiet.
    Mr. Need2save recently posted…Fun Is Important TooMy Profile

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    • Mr WoW April 24, 2017 at 12:20 pm

      I think it’s important that people realize their primary residence is a consumer good. Not an investment. It might go up in value, but should not be bought with that intent. There are obviously reasons to buy a house other than the financial aspect of it.

      Expensive is one way to put it. It’s crazy!! The housing prices are one thing, then you have the highest state-wide sales tax, highest income tax. And the kicker for us.. they tax capital gains as ordinary income!! BOO! I smell a blog post coming on… because I don’t people outside the state really truly understand how expensive it is to live in California. But, yes, we have good weather (and good neighbors).

      Reply
      • Mrs.Need2Save April 26, 2017 at 12:20 pm

        Bring on that California Blog Post!

        Reply
        • Mr WoW April 26, 2017 at 2:10 pm

          I will have to start working on it. There’s some other stuff that I’d like to complain about first… HAHA

          Reply
  • The Raging Mortgage Debate | Need2Save May 7, 2017 at 8:38 am

    […] the West Coast (LA), it sure seems that renting is the way to go and they recently posted about it here.  When you rent, you avoid paying property taxes, insurance, and maintenance costs. Plus, renting […]

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